Institutional reforms

The government must now step back from direct engagement in the economy and focus on correcting market and social distortions

There is a great deal of talk these days that the revival of growth will require major policy reforms. Vijay Kelkar and Ajay Shah in their outstanding book (1) on the art and science of economic policy, give the thumb rule that major policy changes and institutional reforms in the government’s interface with the economy are required with every doubling of GDP. In fact, the authors argue that one should prioritise institution-building over GDP growth. 

India’s GDP since 1950-51 has completed four doublings by 1969-70, 1987-88, 1999-2000 and 2010-11. Could we have experienced four shifts in policy around these times, given the domestic political and international economic environment prevailing then? 

The Nehru-era strategy, with which we began, was appropriate for its day as there was a perceived lack of broad-based entrepreneurship, a shortage of capital that required forced or semi-forced savings and a huge shortage of technological capacity. Mr Kelkar and Mr Shah recognise the value of this strategy for its time, particularly in building both technological and managerial capacity (which helps us to this day) and broadening the entrepreneurial base. But in terms of their thumb rule, a major policy shift and institutional reform should have taken place by the end-1960s/early-1970s. 

One part of what we got then, the emphasis on agriculture and food security, was desirable. But the other shift to a more socialist policy, with bank nationalisation, the state takeover of the wholesale trade in cereals and nationalisation of the coal and oil industries, strong monopoly restrictions combined with anti-poverty policies soon came to grief. One could argue that if this leftward diversion had not taken place, India’s capitalist economy could have matured to a point where it would be ready for large-scale liberalisation by the late 1980s. Perhaps what prevented it was the confused state of politics with the split in the Congress, the Emergency and the ineffective Janata government. The droughts of the mid-1960s and the two oil shocks of the 1970s also hit economic prospects quite hard.

The reforms which should have taken place in the late 1960s/early 1970s started a decade later in 1980s in a modest and tentative way. But growth still depended on the public sector, whose share in fixed investment, rose to over 50 per cent in the 1980s. The major institutional change in policy reform, on a scale that would be consistent with the Kelkar/Shah approach, came in 1991 with the elimination of investment and trade controls, financial sector reforms that liberalised the capital market and a radical change in the outward orientation of the economy. A buoyant global economy, a healthy political environment at home and effective policy leadership helped greatly in this exercise.

Illustration: Ajay Mohanty

The primary focus of the reforms of the 1990s was the interface between the Central government and the private corporate sector and the capital market on which private sector growth depended. The transformation was quite sharp as the share of the private sector in fixed investment rose sharply from below 50 per cent in the 1980s to around 65 per cent in the 1990s and 75 per cent in the first decade of the millennium. The growth boom that one saw in the post-liberalisation period was a product of this pent-up potential finding expression. 

The Kelkar and Shah thumb rule suggests it is time for further major policy and institutional changes, and that these should have taken place at the beginning and again at the end of the first decade of the millennium. There is a recognition of the need for major changes and some basic reforms like goods and services tax (GST) and the Insolvency and Bankruptcy Code (IBC) have taken place. But the focus is still on the interface between the Central government and the private corporate sector. 

In my view the big institutional and policy reforms that we need are in areas which are outside the scope of the corporate sector regulatory system. We need major governance and policy changes in agriculture, micro and small enterprises, education, and major reforms in the organisation of government and the interface with public enterprises amongst others.  In these areas some piece meal efforts have been made. But they do not constitute a fundamental change of approach. The questions that policymakers seek to answer must run deeper.

Can a capitalist economy run efficiently if the bulk of the assets of financial institutions are controlled by the Central government and subjected to political interference in management? Are marginal changes in management, pious statements of intention enough? Or do we need a more radical solution, privatisation, for instance? 

Is an agricultural policy dominated by the support for two cereals, which may have been appropriate for the 1960s and 1970s, right for responding to the present challenge of agricultural income and growth? Should the government step away from direct engagement and work towards devolving policy authority on commodity boards, fashioned on the lines of what have in dairy farming? How can farmers be freed from restrictions of where and to whom they can sell and incentivised to go in for higher-value products, including for exports?

Can a centrally regulated and managed power system continue to be appropriate when the sources of supply involve private generating companies and large numbers of decentralised renewable energy suppliers? How do we move away from bilateral transactions to a wholesale market for transactions in power supply and demand? Can this happen without large-scale privatisation of discoms and decontrol of power tariffs?

Does the governance system of education need to be changed radically to reduce the control of the Central and state government and increase the authority of local bodies and parents and students, say, by moving government support for education from direct grants to institutions to direct transfer to students who can then choose and thus impose pressure for quality improvement?

Can we eliminate the notion of differential treatment for small enterprises and thus reduce the incentive to remain small?

India has grown beyond the stage where it needs a ma-baap sarkar. Its economy is now too complex and too outward-oriented to be managed centrally. Its people and enterprises are now too talented to need hand-holding by public agencies. The Central and state governments must now step back from direct engagement in the economy and focus on what they need to do to correct market distortions, for instance in the impact on the environment, or social distortions like the widening of inequalities. This is the agenda for policy and institutional reform that we need to pursue.

(1) In Service of the Republic: The Art and Science of Economic Policy, by Vijay Kelkar and Ajay Shah, Penguin Random House, 2019: an outstanding overview of policy making that should be read by every policy-maker and commentator
 

nitin-desai@hotmail.com